It is no secret to successful investors that portfolio rebalancing over the long run almost always beats a holding strategy. Diversifying your portfolio is an important first step to lay a foundation for realizing profits from your capital. Rebalancing is the next most effective strategy you can employ to ensure that the portfolio is well positioned to systematically increase your holdings of all your assets over time. Extensive backtesting has proven that rebalancing your crypto assets on a regular basis works equally well in bull or bear markets.
What is rebalancing?
Portfolio rebalancing is a strategy that has been utilized for decades. Savvy investors have applied this technique to extract maximum profits with stocks, forex, and now with cryptocurrencies. Simply put, rebalancing is a periodic adjustment to return your portfolio to the initial allocation percentage of each asset you established. Let’s walk through an example of how to apply this strategy with a portfolio of 4 coins:
For this example the investor will apply an allocation strategy to maintain 25% of BTC, ETH, XRP, and LTC on a $100 initial investment.
User defined asset allocation strategy
The purpose of rebalancing would be to always keep this asset allocation strategy intact, meaning always keeping these 4 coins each at 25% allocation. This is accomplished by selling some amount of certain assets and purchasing others.
In this example let’s say that after 2 days the price of BTC and XRP went up while ETH and LTC went down. The new allocation now looks like this:
Changed allocation due to market movement
To apply the rebalance strategy to this portfolio, we will sell the amount of BTC and XRP that went above the target allocation and buy the amount of ETH and LTC below the target allocation. This returns the portfolio to its initial allocation strategy of 25% per coin. This ensures that you are always taking advantage of dips and rallies for each coin in your portfolio and always buying low/selling high.
Rebalancing allows the portfolio to gain more positive returns over the long run. This is especially true during rapid market fluctuations in high volatility crypto markets. Utilizing SmartBotCoin’s backtesting tools, we extensively tested this strategy against HODL and HODL BTC. Rebalancing proved to be more profitable in the majority of long-term tests conducted
What is Threshold Rebalancing and how do we calculate it?
Threshold rebalancing takes portfolio rebalancing one step further by allowing investors to rebalance their portfolio only when it really matters. This leverages a concept of Allocation Deviation Threshold which determines how much the assets/coins have deviated from the original target allocation as a whole.
Many platforms calculate threshold rebalancing in different ways but, in order to make it easier for our users, we have used a simple approach that is easy to understand and calculate. Let’s apply this to the same example above with the same 4 coins and the same 25% allocation.
For this example the Allocation Deviation threshold will be 10.
When the market price moved in our example above we ended up with this asset allocation:
To calculate Allocation Deviation simply add the absolute difference of each coin’s current allocation percentage from its target allocation percentage.
BTC - |30 - 25| = 5
ETH - |20 - 25| = 5
LTC - |22 - 25| = 3
XRP - |28 - 25| = 3
The Allocation Deviation realized: 5+5+3+3 = 16
This result is higher than the Allocation Deviation Threshold we set at 10. This outcome would trigger the portfolio rebalance to execute. If the Allocation Deviation was less than 10, the portfolio rebalance would be skipped for the time being.
This strategy helps investors minimize the need to run less profitable rebalancing actions and help reduce transaction fees. Extensive backtesting has shown that threshold rebalancing outperformed rebalancing on a set, periodic basis. Using an Allocation Deviation Threshold of 10-15 generated the best overall results.
Backtest and Automate
In order to determine which method works best, you can leverage Capfolio’s Backtesting Tool. This allows users to compare 4 different strategies at once. Once you have determined the best outcome, automate your threshold rebalancing strategy on the SmartBotCoin platform.
Setting up the automation for threshold rebalancing can be accomplished in a few clicks once you have created a Capfolio account and linked you your exchange account.
Signup/Login to your Capfolio account HERE. Instructions for linking an exchange account are in this 2-minute video.
Threshold Rebalancing Set-up
Navigate to EXCHANGES from the main dashboard.
Click on your linked Exchange.
On the Exchange Overview page, click on ACTIONS on the top header to display the menu options.
Click the AUTOMATE option.
Select a rebalance period (example every 1 day).
Select an Allocation Deviation Threshold (example - 10).
Click on AUTOMATE
Once done, Capfolio will automatically initiate a rebalance on your portfolio and then run a rebalance every day (if you selected daily rebalance) as long as the Allocation Deviation Threshold rule is met.
Here is a video of how to set Threshold Rebalancing -
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